Equilibrium Prices in the Presence of Delegated Portfolio Management

Abstract

The paper analyzes asset pricing implications of commonly used performance fees linking the compensation of fund managers to the return of the managed portfolio relative to that of a benchmark portfolio. Symmetric(fulcrum) performance fees distort the allocation of managed portfolios in a way that induces a significant positive effect on the equilibrium prices of stocks included in the benchmark portfolio, a significant negative effect on their equilibrium Sharpe ratios, and a small positive effect on their equilibrium volatilities: these implications of the model are consistent with the available empirical evidence. For Asymmetric performance fees, the signs of differentials between equilibrium stock prices, Sharpe ratios and volatilities of stocks included in the benchmark portfolio and stocks excluded from the benchmark fluctuate stochastically over time, as funds performance relative to the benchmark varies.